If you live in a developed country, did not lose your job and were lucky enough to be able to work from home during the pandemic, you are probably sitting on a pile of cash right now.
And you are not alone. With restaurants, bars and stores closed, no possibility of travels and all kind of limitations that the pandemic brought with it, a lot of people in rich countries saved like never before during the whole lot of last year.
And how these people are planning to spend this saved money will play a big role in what will happen with the world economy in the next few years.
While many people lost their jobs and suffered during the Covid pandemic, the fact remains: The reduced opportunities to spend money combined with furlough schemes, unemployment benefits and stimulus cheques led to rising household incomes in the wealthier countries during 2020.
This created a weird situation: A recession with people accumulating cash at the same time.
Research done by the Economist magazine in 21 developed countries showed that in the first nine months of 2020, people saved $6 trillion dollars.
Had the pandemic not happened, households would have saved $3 trillion dollars. In total, the pandemic meant an excess of $3 trillion dollars saved in 2020.
How this money is spend will be a determining factor in shaping the post-pandemic world economy.
If this excess money is spent all at once, the first world GDP growth could jump 10% in 2021. This number is so high that not even post-war recovery recorded anything even close.
But if that happens, things could not look like a boon, but more like a big bust. This amount of sudden growth rarely comes as a benefit and would be followed by inflation. Worst-case scenario: Long term high inflation.
That’s why a lot of economists are questioning the size of stimulus packages and central bank actions around the world.
Joe Biden $1.9 trillion dollars package approved last March was also a target of criticism.
One of the first to speak out against the size and scope of the stimulus plan was Larry Summers, former Treasury Secretary to Bill Clinton and a former top advisor to President Obama. For him, the stimulus package combined with the amount of money that part of the population saved in the last months can create a very unstable scenario for the United States economy with high inflation and eventually even a recession.
According to him, ”there is a chance that macroeconomic stimulus on a scale closer to World War 2 levels than normal recession levels will set off inflationary pressures of a kind we have not seen in a generation, with consequences for the value of the dollar and financial stability”.
Stating an example, he calculates the situation of a family of four with a pre-tax income of $1,000 dollars per week. Under normal circumstances, this family would take home around $22,000 dollars after taxes in six months. If the head of the household loses his job or her job due to the pandemic and relies on government benefits stipulated by the Biden package, this family could take home more than $30,000 dollars, including regular unemployment insurance, $400 dollars a week special unemployment benefit and tax credits.
This is a big difference between the United States and other developed countries. While in most rich countries, wealthier people have accumulated most of the saved money, in the United States the not rich ones were also able to save.
A study by JP Morgan has found that in December 2020, the poorest Americans’ bank balances were around 40% higher compared to the year before. Among wealthier Americans, this number was 30% higher.
In contrast, the poorest quarter of European household have been 50% less likely to increase savings as the richest. In Britain, the poorest say they have saved less during the pandemic than before. And in Canada, the poorest did not save at all. That is very important because taking into consideration that rich people traditionally treat saved money as wealth, not as income, the risk of a spending spree and higher demand in supply is limited to Europe and Canada compared to the United States.
But demand is not the only thing that will put pressure on prices in the following months. The pandemic created problems that affected supply chains in many different areas.
Port backlogs are a reality in many countries and the rise in demand for electronic products created a shortage of semiconductors that has impacted many sectors, including car manufacturers and tech producers.
On top of that, weather conditions in some parts of the world also disrupted supply chains like the extreme cold in Texas in February 2021 to current floods in Europe and China. And let’s not forget a ship that blocked the Suez Canal for a week in March. According to Bloomberg, due to high demand and supply chain problems, as of May 2021, the world is also low on Copper, Iron, Ore and Steel, Corn, Coffee, Wheat and Soybeans, Lumber, Plastic and Cardboard for packaging.
All of this add worries about the future state of the economy. Usually, when a country is dealing with inflationary pressures, the central banks can act in a very simple way: When there are indication of tendencies toward higher prices and a stimulated economy, the central bank raises the interest rates to make access to money more expensive and therefore reduce economic activity.
This usually leads to lower inflation. When the economy is slowing down, it does the opposite, reducing the interest rates and flooding the market with cheap money. In this case, a little bit higher inflation is usually registered. It has been like this for a while. And in general, in the last decade, if we look at central government targets, lower inflation has been a bigger problem than higher inflation.
But as the economies start to reopen, some fear that the circumstances of excess money combined with supply chain disruptions might make the work of central banks controlling inflation through interest rates much harder.
In the end, there is no way to escape inflation when there is too much money chasing too few goods. And sign of higher prices are starting to be everywhere.
The United Nations’ estimation of global food costs rose for a 10th month in March 2021 to the highest since 2014. U.S. consumer spending on goods was up nearly 10% in January from a year earlier, according to the Commerce Department.
Demand for new houses in the United States is so high that in March 2021 almost half of new listings were selling within a week of hitting the market, according to Redfin, a real estate brokerage. Annual price growth reached 17%. This is the highest growth since 2012.
The Fed already announced that the US economy should recover faster than previously projected. And the recovery of global output returned to pre-lockdown levels by December 2020. This was much faster than in the aftermath of the financial crisis in 2008.
Right now, it’s pretty clear that inflationary pressures are growing, but it is still not clear to what extent, for how long and how the Fed will react to it. These variants are decisive to the state of a post-pandemic world.
Greg Manki, a Harvard economist, considers that inflation will become a problem only if consumer prices rise more than 3% a year for the next five years.
For Jason Furman, a former Obama administration economic advisor, if consumer prices stay between 2.5 and 3.5 percent higher per year, it would already create problems.
Janet Yellen, the Treasury Secretary, has said that she doesn’t see these signs as a problem. She hit back at critics in February 2021 asserting that the United States has the necessary tools to deal with inflation should the need arise.
Those tools are also a source of worry. If they drastically raise interest rates to control inflation, for example, this could set off a new recession domestically and affect the whole world. Past examples are still fresh. Remember the ”Great Inflation of the 70s”? Interest rates were raised to 20%, unemployment skyrocketed and a recession followed.
Higher interest rates in the United States could also mean difficulties for developing countries. A hike in rates combined with a strong dollar will probably mean an outflow of capital from emerging markets followed by recessions and difficult times. If it happens, this could be a big disaster for economies already struggling to recover from the pandemic fallout.
The reality is: As economies slowly reopen and people spend their saved money and stimulus checks, the demand for certain goods and services will exceed supply and generate higher prices.
Right now, most economists seem to agree on that. But the long-term effects of this phenomenon depend on how long it will last and how the United States will react. Depending on what happens, the consequences will be felt everywhere. And the world economy, so used to low inflation controlled by central bank’s interest rates, might never be the same again.
